Valuation anxiety: why expensive markets don't usually fall when investors expect
- Robin Powell
- 2 hours ago
- 10 min read
When markets look expensive, valuation anxiety kicks in fast. Investors brace for a fall, delay decisions, and wait for a correction that feels overdue. History suggests the real danger is quieter: long stretches of disappointing real returns that erode confidence long before prices collapse.
You open your portfolio. Prices look stretched. Headlines talk about froth and late cycle again. And that familiar knot tightens.
Should I wait?
Should I do something?
Surely this can't go on.
If that sounds familiar, you're not alone. Since the early twentieth century, the US market has suffered repeated declines of 20% or more. It has fallen, recovered, and climbed again. Again and again. Yet each time valuations look high, the fear feels new. Personal. Urgent.
And it's draining. Because valuation anxiety doesn't just raise questions about losing money. It makes people doubt their plan. It invites second-guessing. It blurs the line between patience and paralysis.
That discomfort is real. It deserves to be taken seriously. But it is often aimed at the wrong risk.
What history shows is that expensive markets don't usually punish investors the way they expect. Not with an immediate fall that clears the air. More often, the damage arrives slowly. Through inflation. Through long, uneven periods where returns disappoint and confidence leaks away almost unnoticed.
Understanding that difference matters. It changes how high prices are interpreted. And it changes what it means to behave sensibly when markets feel uncomfortable but nothing obvious breaks.
Why "this can't go on" feels so persuasive
When investors say a market looks expensive, they usually mean prices feel detached from everyday reality. Valuation ratios sit above long-run averages. Yields look thin. Future returns feel harder to justify. From there, it's a short step to a stronger conclusion: a fall must be close.
That leap feels reasonable. In everyday life, paying too much usually ends badly. Overpay for a house, a car, or a business and reality eventually catches up. It's natural to assume markets work the same way.
But this is where intuition starts to mislead.
Valuation measures are not alarms. They don't ring when danger is imminent. At best, they describe a starting point — how much investors are paying today relative to earnings or cash flows. They say far less about what will happen next month, next quarter, or even next year.
The common mistake is treating valuation like a countdown clock. Once prices cross some invisible line, gravity is meant to take over. Yet markets don't move to a schedule. Prices can remain elevated for long periods if investors are willing, consciously or not, to accept lower future returns.
Language adds to the confusion. Words like "overvalued" sound like verdicts. They imply error, excess, and correction. In reality, valuation is closer to a probability statement. It shapes the range of long-term outcomes. It does not set the timing.
So when valuation anxiety flares up, it's often because investors are asking the wrong question. They're looking for a signal about when prices will fall, from a tool that was never designed to provide one.
What valuations have consistently failed to predict
Valuation measures have been studied for decades, across markets and eras. The broad academic finding is consistent: valuations contain information about long-term returns but offer little reliable guidance on short-term market movements.
Research by economists such as Robert Shiller, John Campbell, Eugene Fama, and Kenneth French points in the same direction. When starting valuations are high, subsequent long-term returns have tended to be lower than average. When valuations are low, long-term returns have tended to be higher. The relationship is noisy and imperfect, but it appears more stable over decades than over months.
Where valuations struggle is as forecasting tools. High valuation levels have not reliably preceded immediate market declines. Nor have low valuations reliably signalled rapid rebounds. In many studies, the link between starting valuations and returns over the next year or two is weak. Sometimes it disappears altogether.
There are good reasons for this. In the short run, prices are shaped by forces that swamp fundamentals. Interest-rate changes, shifts in risk appetite, liquidity, and sentiment can dominate for long stretches. Markets can stay expensive — or become more expensive still — without breaking any obvious rule.
Valuations also move slowly. Most measures rely on trailing data or long averages. That makes them poor at spotting turning points, which are often driven by abrupt changes in expectations rather than gradual changes in earnings.
The evidence points to a clear limit. Valuations help frame long-term expectations. They do not provide a timetable for market falls. Treating them as timing signals asks them to do a job they have repeatedly failed to do.
Markets don't move neatly from danger to safety
One reason valuation anxiety persists is that investors expect markets to behave in tidy phases. Calm periods give way to excess. Excess leads to collapse. Collapse resets the system.
The historical record tells a messier story. Morningstar's Markets Observer for Q1 2026 charts US market downturns, recoveries, and expansions stretching back decades. What stands out is how much time markets spend either falling, recovering, or climbing unevenly. Recoveries are long. Expansions vary widely. The line between "normal" and "dangerous" is blurry in real time.
This matters because it reframes what risk usually looks like. Discomfort is not an exception. It's the default. Long recoveries and uneven advances are where most returns are earned, even though they rarely feel reassuring at the time.
Seen this way, the idea of waiting for a clear signal becomes problematic. Markets rarely pause at obvious points of judgement. They drift, stumble, and resume in ways that only make sense with hindsight.
When expensive markets kept rising and still disappointed investors
The late 1960s offer a useful test of valuation anxiety. By the standards of the time, US equities were already expensive. Several valuation measures sat well above their long-run averages. Confidence in growth was strong. Many investors were uneasy.
Yet the market did not respond the way anxious investors often expect. It did not fall promptly to correct those valuations. After a setback in the mid-1960s, equities recovered and continued rising. The broad market delivered solid nominal gains and did not reach its eventual peak until the early 1970s.
For investors focused on timing, this was uncomfortable. Valuations had looked high for years, but prices kept moving higher. Waiting for the fall meant waiting a long time.
The disappointment came later, and it came quietly. Over the following decade and beyond, equity investors experienced long stretches of weak real returns. Inflation accelerated and eroded purchasing power. Rallies were interrupted by sharp drawdowns and long plateaus. On paper, markets often appeared to be making progress. In reality, many investors were standing still.
This helps clarify what valuation risk looked like in practice. High valuations did not dictate the moment prices would turn. They shaped the environment in which returns were earned. Starting from elevated prices meant that even reasonable earnings growth struggled to translate into strong real gains.
Investor behaviour compounded the problem. Confidence clustered around a small group of high-quality growth companies. These were widely viewed as safe to own regardless of price. Valuation concerns were acknowledged, then brushed aside. The belief was not that prices were cheap, but that time would take care of things.
Time turned out to be the issue. The adjustment to high valuations did not arrive as a single event investors could identify and respond to. It arrived as a long experience of frustration. Returns lagged expectations. Real wealth grew slowly, if at all.
The lesson is narrow but important. High valuations did not cause an immediate fall. They increased the likelihood of prolonged disappointment instead.
Why investors keep fearing crashes instead of disappointment
Investors aren't wired to fear slow losses. We're wired to fear shocks. A sudden fall grabs attention, triggers emotion, and feels like proof that something has gone wrong. Gradual erosion is easier to miss, and easier to explain away.
Behavioural research suggests people react more strongly to sharp losses than to long periods of mild underperformance, even when the cumulative damage is greater. A crash is vivid. It has dates, headlines, and a story. Disappointment unfolds without a clear moment that demands action.
Market storytelling reinforces this bias. Financial news runs on events. Crashes, panics, and corrections are easy to describe. Long stretches of weak real returns are not. They lack a neat beginning and end. They don't fit cleanly into a headline.
There's also comfort in waiting for a crash. It feels like a plan. It promises clarity. Disappointment offers neither. It forces investors to accept that outcomes can be poor without any obvious mistake being made.
Valuation anxiety in a world of default portfolios
For many investors, valuation anxiety doesn't stem from an active choice. It arrives by default. Modern portfolios are shaped by decisions embedded in indices, pension schemes, and automated processes that most people never change.
In the UK, the majority of long-term savers are placed into default funds through workplace pensions. These funds typically invest globally using market-capitalisation weighting. As a result, a large share of equity exposure ends up in US-listed companies. That reflects market size, not a judgement about valuations.
Engagement with these defaults is low. Most defined-contribution savers remain in the default option year after year. Switching rates are modest. Detailed understanding of asset allocation is limited. In practice, many investors carry significant exposure to US equity valuations without having decided to do so.
This shapes how valuation anxiety is felt. When headlines warn that US markets look expensive, investors may feel stuck between concern and inertia. The exposure feels large. The sense of agency feels small.
What looks like an individual worry is often structural. Understanding that doesn't remove valuation risk. But it does clarify its source. For many investors, the discomfort isn't about a bad decision. It's about living with an exposure they never actively chose.
What valuations can and can't tell investors
Valuations do useful work. Just not the work many investors ask of them.
At their best, valuations help frame expectations. They offer a rough sense of how demanding current prices are relative to the cash flows that support them. Used this way, they inform the range of plausible long-term outcomes rather than predicting the path markets will take.
What valuations can't do is identify exit points. They don't tell investors when enthusiasm will fade or sentiment will shift. Markets can remain expensive for long stretches. Cheap markets can stay cheap.
This distinction matters. Instead of asking when prices will fall, a more defensible question is what returns are plausible over a long horizon, given today's prices. That shift turns valuation from a trigger into context. From something that demands immediate action into something that narrows the range of reasonable expectations — and widens the range of possible disappointment.
How disciplined investors cope when markets feel expensive
When markets look expensive, the hardest part is rarely understanding the numbers. Most investors grasp what high valuations imply for future returns. The real challenge is living with that knowledge without letting it warp behaviour.
Disciplined investors focus less on forecasts and more on process. They accept that discomfort is part of long-term investing. Markets have often looked expensive during periods that later proved rewarding in nominal terms and disappointing in real ones. There's no emotional signal that separates the two in real time.
The urge to act grows when uncertainty rises. High valuations create exactly that setting. Returns feel fragile. The absence of a clear trigger invites second-guessing. Discipline here isn't stubbornness. It's the ability to tolerate ambiguity without reaching for premature conclusions.
Expectation management matters. Investors who cope better tend to reset what success looks like when starting prices are high. Returns may be lower, bumpier, and less satisfying than recent experience suggests. That doesn't make disappointment pleasant, but it makes it survivable.
Time helps too. Valuation anxiety often peaks during strong markets, when prices run ahead of fundamentals. Over longer horizons, the noise fades. Short-term moves that once felt decisive blur into a pattern of progress and setbacks.
Action steps for investors struggling with valuation anxiety
Valuation anxiety rarely eases because new information appears. It eases when the questions investors ask change.
Instead of fixating on whether markets are too expensive, it's often more useful to ask what returns are plausible from today's prices, and over what timeframe. That reframing turns valuation from a trigger into context.
It also helps to separate risk from regret. High valuations raise the risk of disappointment. They don't guarantee a bad outcome. Feeling anxious doesn't mean a mistake has been made.
Deliberately widening the time horizon can help too. Valuation concerns feel most acute when viewed through a short lens. Over longer periods, the absence of certainty becomes easier to live with.
These steps are modest. They don't remove uncertainty. What they can do is help investors engage with valuation anxiety in a calmer, more proportionate way.
The real risk isn't the fall investors fear
Valuation anxiety imagines the wrong ending. When markets look expensive, investors picture a reckoning. A sharp fall. A clear signal that caution was justified.
History suggests it rarely works like that.
More often, markets disappoint quietly. High starting prices don't need a crash to do damage. They simply make it harder for returns to compound in real terms. Inflation eats away at gains. Setbacks interrupt progress. Years pass where nothing breaks, yet little feels achieved.
Valuation anxiety isn't irrational. It reflects an instinctive sense that price matters. The mistake is expecting that concern to be rewarded with a clear turning point. The more common test is endurance — living through periods where nothing obvious goes wrong, yet the cost of high valuations is paid slowly, and mostly out of sight.
Resources
Campbell, J. Y., & Shiller, R. J. (1988). Stock prices, earnings, and expected dividends. Journal of Finance, 43(3), 661–676.
Campbell, J. Y., & Shiller, R. J. (1998). Valuation ratios and the long-run stock market outlook. Journal of Portfolio Management, 24(2), 11–26.
Fama, E. F., & French, K. R. (1988). Dividend yields and expected stock returns. Journal of Financial Economics, 22(1), 3–25.
Shiller, R. J. (n.d.). Online data: Irrational Exuberance. Yale School of Management.
Morningstar. (2026). Markets Observer: Q1 2026. Morningstar Research.
Prefer watching to reading?
Subscribe to our YouTube channel for evidence-based investing insights explained visually. Complex concepts made clear in under 10 minutes. New videos every week — hit subscribe so you never miss one.